By Nikolaos Panigirtzoglou and Robert Scammell of the Bank’s Monetary Instruments and Markets Division.
Equity valuations are important for monetary policy makers as the factors that drive equity valuations may contain information about the future course of the economy. Moreover, a possible correction in equity prices may be a source of shocks to which monetary policy may have to react. Such an equity market correction may also have negative implications for financial stability. We use a three-stage dividend discount model to see whether analysts’ forecasts can explain the level of equity prices over the past ten years. This model is also used to decompose equity returns into changes to earnings, the yield curve and equity risk premia.